One year on from the revelation of Dubai World’s debt problems the emirate is looking to the foundations of its prosperity – its position as a trade, transport and services hub – for recovery. Can Dubai trade its way out of trouble?
Published in Euromoney, December 2010

The business strategy of Abdul Salam, a Dubai-based Iranian spice trader, is admirably straightforward. "I buy from everywhere in the world. I sell to everywhere in the world," he says. However, the trade is not without its difficulties. Sitting in his office filled with sacks of turmeric, black peppercorns and dried lemons, he concedes that although trading volumes have remained high despite the downturn over the past two years, profit margins are under pressure.

Salam’s strategy and his fortunes reflect those of the rest of the city around him. Trade has traditionally been at the heart of the emirate’s economy but the past decade’s boom and bust has meant that Dubai has been finding it harder to make its economy work of late.

Salam’s business is based in Deira – an area on the eastern shore of Dubai Creek that is home to a multitude of trading houses and souks. Indians, Pakistanis, Bangladeshis, Iranians and others buy and sell almost everything, from juvenile sharks caught in the Gulf waters to Madagascan cloves, Japanese tyres and South Korean electrical goods.

For spice traders such as Salam, Iran, China and India are the key markets. Trade with Iran is particularly active. The nearby wharves of the Creek are crowded with goods waiting to be shipped in dhows to Iranian ports 12 hours away across the Gulf. Further along Dubai’s coast, at Jebel Ali port, long-distance container ships unload cargo, which is transshipped to the rest of the region in smaller boats.

These hubs of activity might seem remote from the brash hotels, shopping malls and artificial islands that have come to symbolize the emirate for many but it is in such places that Dubai built its economy and where it now needs to regain its momentum. The economy has been in trouble since late 2008 when the debt-fuelled real estate bubble burst. Many in the emirate were quick to blame their problems on the international financial crisis. In truth, though, Dubai was following an unsustainable strategy of borrowing heavily to invest in speculative projects.

The nadir came in November 2009 when government-owned conglomerate Dubai World shocked international markets by seeking to delay repaying its debts. Since then Dubai World has slowly rebuilt its reputation among investors, agreeing a $25 billion debt-restructuring deal with creditors over the summer. The emirate has many more problems to tackle but confidence appears to be returning.

"The problems we’ve always known are still there: the issues with debt, the issues with the real estate sector, the pressure on public finances," says Simon Williams, chief economist at HSBC Middle East. "It was a shock 12 or 18 months ago when real estate prices went down, or when people were pushing for restructurings. That’s now priced in. What’s being missed is how well parts of the real economy are performing.

"Its core [strength] is as an exporter and generator of services to a region that is in growing need of them and has nowhere else that offers them. If you are in the region and you want to access retail, wholesale trade or logistics, or if you want leisure, media, financial, legal or healthcare services and you’re within a two-hour flying time, you come to Dubai."

Positive signs

The resilience of Dubai’s trading activities has been highlighted by the surprisingly consistent numbers from Dubai airport and ports operator DP World.

Dubai International Airport accounts for 98% of passenger arrivals in the emirate and has enjoyed steady growth over the past two years, with strong demand from US, European and Asian customers. With 120 airlines serving 210 routes, it is now the sixth-busiest airport in the world for international passengers and the third-busiest international cargo airport, according to Airports Council International, a global association of airports.

"Most months we’ve been in double-digit growth," says Paul Griffiths, chief executive at Dubai Airports. "The whole economy has been kept going by the transport sector. The Asian market is growing very strongly. Our top destination is still London [but] India is our biggest single country."

DP World remained profitable throughout the downturn and, according to its chief executive, Mohammed Sharaf, the volume of containers passing through its UAE ports is now back to the record levels reached in 2008.

The growing links with Asian economies, coupled with the logistics infrastructure and the open nature of its economy, means that Dubai is now in a good position to recover, according to local economists.

"It is not global trade that has picked up, it is trade with Asia," says Nasser Saidi, chief economist at the DIFC Authority, the body that runs the Dubai International Financial Centre. "The driving motor of the global economy is increasingly Asia – that is China, India and other emerging markets. But the engine is clearly a Chinese engine. What Dubai is benefiting from is the fact that today Asia is the largest trading partner of the GCC countries.

"What you need to do is think where the growth markets are, and the growth markets are not in the US or Europe. The future for the Gulf countries is to increasingly get integrated into China’s global supply chain and that is precisely what is happening."

The DIFC has taken its share of this trend, with most new companies basing themselves at the financial zone over the past year coming from India, China and Turkey, according to Saidi.

The second, equally important element to Dubai’s economic future is to build on its position as a trading hub for the region – allowing other countries across the Gulf and parts of Asia and Africa to use its facilities to connect with the rest of the world. Although other Gulf countries such as Qatar and Bahrain are also developing their ports and airports, the downturn has not greatly eroded Dubai’s substantial lead.

"Dubai’s real economy seems to be on the mend," says Tristan Cooper, head analyst for Middle East sovereigns at Moody’s Investors Service. "Proxy indicators such as throughput at the emirate’s port and airport and tourism data indicate that Dubai’s core service sectors have proven quite resilient and are growing at a healthy pace."

There are other signs of improvement. Credit ratings are creeping up, having taken a battering over the past two years. In October, Standard & Poor’s raised the rating of Thor Asset Purchase, which provides funding to Dubai Electricity & Water Authority, to BBB– from BB+. Then, in November, Moody’s improved the outlook on DP World’s Ba1 rating from stable to positive.

The emirate even managed to sell $1.25 billion in five- and 10-year bonds in September, with demand from investors for up to $4 billion. Most economists are forecasting growth rates of up to 3% this year.

Debt overhang

Before growth rates can accelerate though, the emirate will need to address some of its lingering serious problems. Dubai World has reached an understanding with its creditors but the emirate’s total debt is thought to be about $105 billion and much of it is owed by other government-owned companies. Another conglomerate, Dubai Holding, has repeatedly postponed the repayments of some of its debts. Last month it received a $2 billion capital injection from the government. The investment vehicle, which is owned by Sheikh Mohammed bin Rashid, the ruler of Dubai, is renegotiating about $12 billion of debts. One of the most troubled companies within Dubai Holding is Dubai Group, its financial arm, which is in talks with creditors.

"The main cloud on the horizon is still the emirate’s large debt overhang," says Cooper at Moody’s. "Despite the recent restructuring of Dubai World’s debt, the emirate faces substantial annual debt maturities. The bulk of the debt is owed by the public sector – mainly government-owned companies. Given the fragile state of many of these, we would not rule out further debt restructurings."

In trying to deal with this, the government is unable to draw on one key policy tool that other countries use – taxation.

"The main challenge for the government is revenue generation," says Cooper. "It is difficult for the government of Dubai to widen its tax net because of the absence of VAT and income tax in the rest of the Gulf."

However, there is now much greater confidence that the debt issue can be dealt with. Another local economist says: "A lot of debt remains outstanding and will need to be refinanced, but the deal between creditors and Dubai World gave everyone confidence that it could be dealt with."

The short tenor on much of the debt highlights one of Dubai’s fundamental weaknesses, which led to the downturn being so severe.

“The main issue that Dubai faced was one of classical mismatching in terms of the sources of finance and what it was using it for," says DIFC’s Saidi. "It was using short-term finance for long-term projects, using three-year money to invest in 15-year projects."

Dubai companies might need to sell some of the overseas assets they bought during the past decade to fund their debt repayments. Most of the Gulf countries have been on a global spending spree in recent years, for example buying stakes in Ferrari, Harrods and the Chrysler Building in New York. But although most of them were able to fund their acquisitions with oil revenues, Dubai does not have the luxury of oil income and typically had to borrow to pay for its purchases.

The overseas portfolios were put together when prices were high and selling now might involve taking a loss – one reason why Dubai has until now avoided disposals where possible, despite saying it was willing to sell what needed to be sold.

Along with overseas trophy assets, much of the debt built up by Dubai companies was to fund the investments they were making in real estate schemes in the emirate itself. In many parts of the city, the landscape is punctuated by half-built apartment blocks and office towers. While cranes are moving on some sites, there are many more where work has ground to a halt. Many of the completed buildings along Sheikh Zayed Road, the city’s most important thoroughfare, have To Let signs hanging outside. The real estate boom provided more accommodation and office space than Dubai will need for many years to come.

"I see a lot of spare capacity in this economy right now, in the real estate sector and in the labour market as well," says HSBC’s Williams. "You don’t have the growth in demand to meet the growth in supply by any stretch of the imagination. You’re seeing pressure on margins and prices coming down, but from where I sit that’s no bad thing. I realize it causes distress, but falling prices mean that Dubai is becoming competitive again. For me that drop in prices is part of the recovery story. It’s a painful part but it’s a necessary part."

Other issues will be harder to deal with than the debt or the surplus real estate. Dubai has a tiny indigenous population – some 85% of residents are expatriates. With many of them in the emirate for just a few years to earn as much tax-free income as they can, it is easy for short-term attitudes to prevail. When things go wrong, they can simply get on a plane and leave, as many did during the recent downturn. Marios Maratheftis, head of global markets research at Standard Chartered Bank, estimates that as many as 15% of all jobs were lost in Dubai at the height of the crisis in the first quarter of 2009, although the situation has stabilized since then.

Even those that stay tend to repatriate a high proportion of their income, which is a further weakness for the local economy.

"A strategic aim [must be] to retain your expatriate population because that’s a good part of your human capital and you don’t want to pay the price each time around, to retrain them every two or three years, especially if those people are not investing back into your economy," says DIFC’s Saidi.

The culture of secrecy and the lack of transparency also need to be overcome, perhaps faster than in the past. The shock that greeted Dubai World’s debt standstill announcement in November 2009 was exacerbated by its timing – the company issued its statement just before the Thanksgiving and Eid holidays, which meant that investors could do little to react to the news. In turn, the way the news emerged exacerbated the subsequent negative reaction many had towards the emirate.

Disclosure requirements

Some lessons appear to have been learnt, and the quality and consistency of company disclosures is improving as companies seek access to a wider range of investors.

"Much of [the company disclosure] in the west has to do with taxation," says Saidi. "The reason why you have the information disseminated is because you have to report for tax purposes, but there has never been much reporting for tax purposes in the GCC countries. You never had to report to the authorities on income and company accounts. The main impulse [for more disclosure] has now come because you might want to list or to access finance through the banking system. That is forcing better transparency and much more disclosure than we had before.

"It is not so much a question of transparency and disclosure. What you really need is accountability. What I’ve seen in the last few years is much better accountability than we’ve had in the past."

Cooper agrees that the situation has improved, but says far more needs to be done. "The higher disclosure requirements of bond issuance versus bank financing have encouraged local companies and the government of Dubai itself to improve transparency," he says. "This is encouraging, but there is still some way to go. The level of transparency in Dubai continues to lag behind that of many other emerging markets."

The sense that things have improved but more needs to be done underpins much of the atmosphere in Dubai these days. The naive hubris and arrogance that the city once suffered from was washed away in late 2008 and, as yet, has not returned. After the overriding pessimism of the past two years, optimism is returning, tinged with a healthy dose of realism – most people are just happy that something is getting built at all.

In an effort to maintain Dubai’s position as the leading trading hub in the region, a new airport, Al Makhtoum International, is being built, but far more slowly than originally envisaged. A metro rail network is gradually expanding and is proving more popular than many sceptics had imagined, although several additional lines are on hold indefinitely and some will probably never get built.

As Dubai moves forward there are other things it can do to insulate itself from the dangers of another debilitating recession. Like other Gulf countries, it would benefit from having a more developed domestic financial market, so that it does not have to borrow abroad in foreign currencies.

"When you needed the capital and the liquidity it was abroad in US treasury bills – not very useful when you need to reinject liquidity into your own economy and to finance your companies," says DIFC’s Saidi. "So the big lesson is that they need to turn inwards to develop their own local interbank money markets and local-currency debt and equity markets."

But more was achieved in the boom than perhaps many people realize. Dubai is a playground for people across the Gulf and other nearby countries and it boasts the world’s tallest building in the shape of the Burj Khalifa, but what is more important is that it maintained and even improved its position as the regional hub for trade and finance.

From one end of the city to the other, however, there are reminders of the excesses of the recent past. From empty plots of land in Dubai Media City in the west where 200-metre-tall buildings were due to rise up, to the half-completed islands of Palm Deira in the east. The latter was to be the third and largest of the palm archipelagos but the project was put on hold in November 2008 and, for now, all that marks it out are some lifeless and lonely patches of reclaimed land off the coast, with short stretches of road on them leading nowhere.